Recommendations of the ABI Commission to Study the Reform of Chapter 11: Preference Claims

From time to time it has proved beneficial to revisit existing bankruptcy statutes, and update them where necessary. The American Bankruptcy Institute established the Commission to Study the Reform of Chapter 11 (the “Commission”) for this precise purpose, and on December 8, 2014 the Commission published its recommendations. If enacted by Congress, some of those recommendations might affect a trustee's ability to avoid and recover preferential transfers under Bankruptcy Code section 547.

The primary goals of preference law are (i) to equalize distribution, and (ii) to maximize estate value. As originally contemplated, a trustee could recover payments or property transferred to creditors prepetition to the extent those transfers preferred such creditors over other similarly situated creditors. The trustee would then distribute the recovered value to all similarly situated creditors.

Unfortunately, in practice the application of preference law may have deviated from those goals. The Commission found that in many cases, the value of preference recoveries is no longer reallocated among general unsecured creditors. Instead, secured creditors are granted liens in preference claims and recoveries as part of adequate protection, cash collateral, or debtor-in-possession financing orders. Further, testimony received by the Commission during public hearings suggests that some trustees pursue preference actions with little diligence, and without regard to the merits of the underlying claim. Some trustees also appear to file preference actions not necessarily to recover the alleged preference, but to extract a settlement payment.

The Commission discussed different options for addressing these concerns, and made the following observations and recommendations:

• The trustee’s ability to pursue preference claims under section 547 preserves value for the estate and tempers the “run on the debtor” that may occur immediately prior to a bankruptcy filing. The avoiding power in section 547 may, however, be subject to abuse in certain cases. The Commission analyzed a variety of potential reforms to section 547, including refining elements of, or shifting the burden of proof for, certain defenses under section 547(c). After much research and deliberation, the Commission determined that the potential abuses under section 547 are addressed most effectively through the changes in small preference actions, pleading requirements, and demand requirements described in these principles, and continued judicial oversight in accordance with the Bankruptcy Code.

• The trustee should be precluded from issuing a demand letter to, or filing a complaint against, any party for an alleged claim under section 547 unless, based on reasonable due diligence, the trustee believes in good faith that a plausible claim for relief exists against such party under section 547, taking into account the party’s known or reasonably knowable affirmative defenses under section 547(c).

• The trustee must plead with particularity factual allegations in the complaint that establish a plausible claim for relief under section 547. In accordance with the U.S. Supreme Court’s decisions in Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007), and Ashcroft v. Iqbal, 556 U.S. 662 (2009), legal conclusions or speculative allegations should not be sufficient to support a preference complaint.

• The dollar amount of the defense against preference claims provided in section 547(c)(9) (which provides a threshold amount below which a preference complaint cannot be filed) should be increased to $25,000 in the aggregate. This dollar amount should continue to be increased based on the Consumer Price Index for All Urban Consumers.

• The small claims venue provision in 28 U.S.C. § 1409(b) (providing that claims smaller than a threshold amount may be filed only in the district court for the district where the defendant resides) should be amended to (i) clarify that the section applies to preference actions under section 547, and (ii) increase the dollar limit for debts (excluding consumer debts) against noninsiders to $50,000 in the aggregate. This dollar amount should continue to be increased based on the Consumer Price Index for All Urban Consumers.

 The Commission elected not to make a number of other recommendations that might have benefitted preference defendants. Among these are:

• Establishing a presumption in favor of the creditor that the prepetition transfer was in the ordinary course of business, which the trustee could rebut as part of its prima facie case.

• Supplementing the elements of section 547(a) with an affirmative statement concerning the diligence performed by the trustee to evaluate the merits of the preference claim in light of any section 547(c) defenses available to the creditor.

• Implementation of fee shifting or sanctions and a straight, "loser pays" rule.

The Commission's recommendations are just that – recommendations – and in all likelihood it will be some time, if ever, before the recommendations are considered by Congress.

Preferential Transfers, Twombly, insolvency-insights